Canada has recently experienced a spurt of new technologies relating to computers, communications, and biotechnology. Technological advances have dropped the prices of computers and greatly enhanced their speed. Cellular phones and the Internet have increased communications capacity, enhancing production and improving the efficiency of markets. Advances in biotechnology, specifically genetic engineering, have resulted in important agricultural and medical discoveries. Many
Part One • An Introduction to Economics and the Economy economists believe that these new technologies are so significant that they are contributing to faster-than-normal economic growth (faster rightward shifts of the production possibilities curve).
In some circumstances a nation's production possibilities curve can collapse inward. For example, in the late 1990s Yugoslavia forces began to "ethnically cleanse" Kosovo by driving out its Muslim residents. A decisive military response by Canada and its allies eventually pushed Yugoslavia out of Kosovo. The military action also devastated Yugoslavia's economy. Allied bombing inflicted great physical damage on Yugoslavia's production facilities and its system of roads, bridges, and communication. Consequently, Yugoslavia's production possibilities curve shifted inward.
Economic Systems economic system A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem.
MARKET SYSTEM An economic system in which property resources are privately owned and markets and prices are used to direct and coordinate economic activities.
COMMAND SYSTEM An economic system in which most property resources are owned by the government and economic decisions are made by a central government body.
Every society needs to develop an economic system—a articular set of institutional arrangements and a coordinating mechanism—to respond to the economic problem. Economic systems differ as to (1) who owns the factors of production and (2) the method used to coordinate and direct economic activity. There are two general types of economic systems: the market system and the command system.
The private ownership of resources and the use of markets and prices to coordinate and direct economic activity characterize the market system, or ca italism. In that system each participant acts in his or her own self-interest; each individual or business seeks to maximize its satisfaction or profit through its own decisions regarding consumption or production. The system allows for the private ownership of capital, communicates through prices, and coordinates economic activity through markets—places where buyers and sellers come together. Goods and services are produced and resources are supplied by whoever is willing and able to do so. The result is competition among independently acting buyers and sellers of each product and resource. Thus, economic decision making is widely dispersed.
In ure capitalism—or laissez-faire capitalism—government's role is limited to protection private property and establishing an environment appropriate to the operation of the market system. The term laissez-faire means "let it be," that is, keep government from interfering with the economy. The idea is that such interference will disturb the efficient working of the market system.
But in the capitalism practised in Canada and most other countries, government plays a substantial role in the economy. It not only provides the rules for economic activity but also promotes economic stability and growth, provides certain goods and services that would otherwise be underproduced or not produced at all, and modifies the distribution of income. The government, however, is not the dominant player in deciding what to produce, how to produce it, and who will get it. These decisions are determined by market forces.
The alternative to the market system is the command system, also known as socialism or communism. In that system, government owns most property resources and economic decision making occurs through a central economic plan. A government central planning board determines nearly all the major decisions concerning the use of resources, the composition and distribution of output, and the organization of chapter two • the economic probLem: scarcity, wants, and choices production. The government owns most of the business firms, which produce according to government directives. A central planning board determines production goals for each enterprise and specifies the amount of resources to be allocated to each enterprise so that it can reach its production goals. The division of output among the population is centrally decided, and capital goods are allocated among industries on the basis of the central planning board's long-term priorities.
A pure command economy would rely exclusively on a central plan to allocate the government-owned property resources. But, in reality, even the pre-eminent command economy—the Soviet Union—tolerated some private ownership and incorporated some markets before its demise in 1991. Recent reforms in Russia and most of the eastern European nations have to one degree or another transformed their command economies to market-oriented systems. China's reforms have not gone as far, but have reduced the reliance on central planning. Although there is still extensive government ownership of resources and capital in China, it has increasingly relied on free markets to organize and coordinate its economy. North Korea and Cuba are the last remaining examples of largely centrally planned economies.
THE CiRcuLAr FLOW ModEL
resource MarkEt A market in which households sell and firms buy resources or the services of resources.
prddugt markEt A market in which products are sold by firms and bought by households.
circular flow model
The flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms.
Because nearly all of the major nations now use the market system, we need to gain a good understanding of how this system operates. Our goal in the remainder of this chapter is to identify the market economy's decision makers and major markets. In Chapter we will explain how prices are established in individual markets. Then in Chapter 4 we will detail the characteristics of the market system and explain how it addresses the economic problem.
As shown in igure 2-6 (Key Graph), the market economy has two groups of decision makers: households and businesses. It also has two broad markets: the resource market and the product market
The upper half of the diagram represents the resource market: the place where resources or the services of resource suppliers are bought and sold. In the sources market, households sell resources and businesses purchases them. Households (that is, people) own all resources either directly as workers or entrepreneurs or indirectly through their ownership (through stocks) of business corporations. They sell their resources to businesses, which buy them because they are necessary for producing goods and services. The money that businesses pay for resources are costs to businesses but are flows of wage, rent, interest, and profit income to the households. Resources therefore flow from households to businesses, and money flows from businesses to households.
Next consider the lower part of the diagram that represents the product market: the place where goods and services produced by businesses are bought and sold. In the product market, businesses combine the resources they have obtained to produce and sell goods and services. Households use the income they have received from the sale of resources to buy goods and services. The monetary flow of consumer spending on goods and services yields sales revenues for businesses.
The circular flow model shows the interrelated web of decision making and economic activity involving businesses and households. Businesses and households are both buyers and sellers. Businesses buy resources and sell products. Households buy products and sell resources. As shown in Figure 2-6, there is a counterclockwise real flow of resources and finished goods and services, and a clockwise money flow of income and consumption expenditures. These flows are simultaneous and repetitive.
Part One • An Introduction to Economics and the Economy
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